Housing crisis lesson: Flexibility also adds risk

Individuals far wiser than I warned me about the coming housing crisis back in 2005.

However, it is the very nature of economic bubbles that for most of us mere mortals, it is nearly impossible to detect inflated markets until after the fact.

Also, in an era of rising home prices coupled with new, creative financial options, it seemed foolish not to jump into the market with both feet. Builders kept building and lenders -- some highly questionable -- kept lending and households kept borrowing.

As a result, we are in a serious housing slump with a high number of homes in the foreclosure process, high inventories of unsold homes, falling prices and sharp reductions in housing starts.

More than 11,000 homes are currently in the long and painful process of foreclosure in the six metro areas of western Michigan, according to RealtyTrac. It is not known how many of these houses are owner-occupied -- many could be rental.

This represents 1.8 percent of the region's single-family housing units as measured by the U.S. Census Bureau in their 2006 American Community Survey. Of course, not all of these homes will be foreclosed. However, it does suggest that many of our neighbors are living in the awful fear of losing their homes.

In addition, like the rest of the nation, the region's residential construction industry slid into a slump. The number of building permits issued for single-family housing in the metro areas fell at a 26.1 annualized rate from 2004 to 2007. During the first 10 months of 2007, 40 percent fewer building permits were issued in the region than in the same period in 2004.

In the rest of the state, the number of building permits for single-family housing units fell at a slightly higher annualized rate -- 27.1 percent. Nationwide, the rate of decline was less steep, falling at a 14.3 percent annualized rate.

Finally, although regional data are spotty, evidence suggests that housing prices are in retreat. In the greater Grand Rapids area, the median sales price of a single-family home has fallen by 3.2 percent since 2004.

It is too easy to blame the victim in these situations. Some homeowners and buyers were foolish in not reading and understanding the "mice print" on the mortgages and equity loans they were signing. However, for many others, it was a serious illness, a bad divorce or the loss of a job that triggered the fall.

Yes, some builders were simply too bullish. At the same time, economic-trend data supported further construction, and a lot of money can be lost by not building if the market is growing.

Of course, there is movement on the federal and state level to tighten lending regulations and provide counseling and financial assistance to households in need. However, these are reactive measures -- locking the garage door after the car has been stolen.

So what can be learned from this mess?

While it is wise to remain open to new ideas, one must remember that a "creative" or "innovative" process or product can hold as much risk as promise. Lending standards are based on years of experience. Therefore, when products are introduced that loosen these standards or offer more "flexibility," they also add risk and uncertainty.

Finally I am again reminded of what my marketing friends constantly say: When the crowd moves in, it is time to seriously re-examine the situation.

Even in today's fast-paced environment, there are information lags. Moreover, almost all new markets have limited life spans. Therefore, by the time a majority of potential participants accept that the market is strong, the market may be in its mature -- if not declining -- years.

George Erickcek is the senior regional analyst for the W.E. Upjohn Institute for Employment Research, a not-for-profit independent economic research organization. He also writes the Institute's quarterly publication, Business Outlook for West Michigan, which tracks economic trends in western Michigan. Business Outlook is available free on the Institute's Web site, upjohninstitute.org. To be notified when the next issue of Business Outlook is released, e-mail wertz@ upjohninstitute.org.